US Defense department takes tough look at services contracts

RebeccaChristie

WASHINGTON (MarketWatch) -- The U.S. Defense Department is beefing up the way it buys services, in a new effort to save money and avoid the type of controversy that has plagued a series of Halliburton Co. (HAL) troop support contracts.

The Pentagon is reviewing all of its services contracts worth more than $1 billion, a senior Defense Department official told Dow Jones Newswires. The Department also has added new training for its contracting professionals, and it is preparing a series of reports on service purchasing practices across the military services.

Among other changes, the Defense Department wants to move away from its past habit of holding a single competition for years of subsequent work. This practice led to serious criticism of battlefield logistics contracts awarded to former Halliburton unit KBR Inc., (KBR) for troop support in the Balkans and the Middle East.

"What we need to do is really put more discipline into the system of how we go about buying different services," said Shay Assad, the Pentagon's director of defense procurement and acquisition policy, in a recent interview.

"We buy an incredible amount of services in any particular year and now we buy more, we spend more on services than we do on major hardware," Assad said.

The Pentagon budget has come under increasing strain from aging equipment, health care and war costs, putting pressure on managers to cut costs wherever possible. The new services review aims to streamline and focus the service-buying process, Assad said.

Under the services plan, the Pentagon will look for new ways to keep as much competition in the system as possible. The Department also wants to adapt the way it awards umbrella contracts so that small businesses and other disadvantaged groups can win some of the work.

Defense service contracts range from aircraft maintenance to administrative services, base landscaping and technical support. In 2005, the most recent year for which data were available, the Pentagon spent about $143 billion on services contracts.

Most of the Pentagon's biggest contractors also lead the list of service providers. Lockheed Martin Corp. (LMT), Halliburton, Northrop Grumman Corp. (NOC), Boeing Co. (BA) and Bechtel Group Inc. have led the list of top service providers in recent years, with L-3 Communications Holdings Inc. (LLL), Science Applications International Corp. (SAI) and Electronic Data Systems Corp. (EDS) not far behind.

Despite the big budget, services contracts have historically been hard to track. Because these contracts span so many areas, there has been little centralized oversight. Also, service contracts are often awarded under blanket contracts, which can make it hard to track individual payments or measure performance specifically.

Last month, the Government Accountability Office called on the Pentagon to step up its reform efforts. GAO officials say the Defense Department needs to keep better track of risk factors, contract oversight and purchasing procedures.

"DoD's approach to buying services is largely fragmented and uncoordinated," GAO said in its November report.

Assad said the Defense Department concurs with GAO's recommendations and is taking steps to change its system. A new report, due early next year, will "completely reassess" the Pentagon's overall approach to services buying.

The Defense Department also is reviewing its workforce, through a new "human capital" assessment. And it has asked two trade groups, the Professional Services Council and the Contract Services Association, for analysis and recommendations.

In the meantime, new procedures already are taking effect, Assad said. His office recently assessed new contract efforts planned by the Army and the Air Force, with more to follow.

The Pentagon expects 10 to 20 new contracts that will top the $1 billion threshold, triggering a slate of new review procedures. This stepped up oversight builds on a 2005 plan to review contracts over $2 billion, which was announced by chief Pentagon weapons buyer Ken Krieg during congressional testimony. Assad said the Defense Department lowered the threshold to add flexibility to the services review.

The upcoming Air Force contract is a multi-billion dollar plan for aircraft maintenance services. Assad said plans call for a contract structure that will identify qualified companies to compete for individual assignments.

The Army also wants to change its approach to logistics contracting. Assad said his office signed off on the next round of "LOGCAP" battlefield logistics contracts, which are designed to avoid future dependence on a single company.

"We're putting a strategy in place that will ensure that we don't go down that path again," Assad said.

Halliburton and KBR have defended their war-zone contracts as fairly won and executed to the satisfaction of the government. Nonetheless, the contracts have drawn scrutiny on Capitol Hill over various accounting issues.

Industry officials have welcomed the Defense Department's new efforts to get services contracting under control. Stan Soloway, president of the Professional Services Council, praised Assad for realizing that services contracts come in many shapes and sizes and need a range of approaches.

With better planning, the Pentagon and its contractors will be able to avoid the snags and cost questions that have plagued support for operations in Iraq and Afghanistan, Soloway said. Most of the difficulties have stemmed not from fraud and abuse, but from insufficient planning, he said.

"We were not strategic and didn't have a set of business practices in place to appropriately support a mission that big, that fast," Soloway said.

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